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Taming the dragon

Economist argues that Vietnam should pursue a slow, holistic approach to solving its economic woes

A branch of SeABank in Ho Chi Minh City now offers 14 percent per year on dong deposits. A university professor said a â€śwarâ€ť between banks directly led to high interest rates.

Interest rates on dong deposits at some banks have exceeded the 14 percent cap set by the central bank. Meanwhile, lending rates have been pushed beyond what most businesses can afford.

Professor Le Tham Duong, one of Vietnamâ€™s leading economists, argues that Vietnam needs to take things slow and steady. The Ho Chi Minh City Banking University lecturer said that a new cap on lending rates will not work. He says the problem can only be effectively addressed at its root.

Thanh Nien: Many different measures have been proposed to lower interest rates, from imposing a rate cap to forcing banks to set aside more reserves. It seems like we donâ€™t even know what the best thing to do is anymore. Why is it so hard to solve this interest rate problem?

Le Tham Duong: The main reason behind rising interest rates is inflation. It may sound paradoxical but when combating inflation we have to remember that, if we want quick results, we have to take things slow.

Vietnam has been reporting high inflation for five months now, but things will start cooling down this month â€“ the governmentâ€™s recent anti-inflation measures have already begun to show their effect. We cannot just fly into a panic. If we donâ€™t stay cautious, weâ€™ll just mess the whole thing up.

A central bank source mentioned a plan to end the interest rate cap on deposits and replace it with a cap on lending rates. Do you think it would be a good move?

Iâ€™m certain that if lending rates were capped, deposit rates would fall, with or without a cap on them.

If deposit rates are low, people will not put their money into banks. Just look at the figure in April â€“ deposits actually declined even though banks offered up to 19 percent on dong savings.

A limit on lending rates would have many consequences.

Firstly, banks would sharply cut back on medium and long-term loans. Because they canâ€™t set rates higher than the cap, theyâ€™ll just seek out short-term loans that carry fewer risks.

Lenders could also shut out small- and medium-sized enterprises for the same reason. In this case, the move would do nothing to ease capital pressures.

If a restriction is placed on lending rates, banks will just try to dodge it, like they did in 2008. They will also come up with various additional fees to avoid getting caught breaking the new rate cap.

The current deposit cap may result in high lending rates, like 25 percent a year. But if that cap is lifted, itâ€™s possible that banks would enter a race, competing against each other with high rates to attract more deposits. Lending rates would not just be 25 percent then.

So what should we do?

Inflation is the main problem. But we also need to be aware of a â€śwarâ€ť between banks that directly led to high interest rates.

Small banks offered high deposit rates because they needed to attract deposits to improve their liquidity. Then larger banks followed suit, arguing that they needed to do the same thing or risked losing clients.

The larger banks always win. They have a lot of funds, but they are required to keep their credit growth under 20 percent. So they lend money to smaller banks. And when they do so, they sort of â€śswallowâ€ť their small rivals by setting rates at 22-23 percent.

If we want to deal with the situation, we need to defuse the problem at its source: the banking system.

And how can we do that?

Small lenders have liquidity problems while larger banks only care about their own bottom line.

The central bank could help small lenders by providing loans through open-market operations. That way, these small banks wonâ€™t have to borrow from large banks anymore.

To deal with large banks, the central bank could just set a cap on interbank loans to prevent one bank from overcharging another.

Then, the race between banks would lose its steam and interest rates would fall.

Your â€śdefusingâ€ť solution doesnâ€™t sound so simple, does it?

Not at all. You have to realize that itâ€™s just a short-term solution for this moment. In the long term, several things need to happen at the same time.

First, we have to strictly follow Resolution 11, which the government passed to restore economic stability by cutting public investment and spending.

On the monetary front, the government should review credit flows in the economy. We need to steer credit toward the production sector, and to small- and medium-sized enterprises, in particular. Right now these small companies are desperate for cash and theyâ€™ll accept any interest rate thatâ€™s offered to them.

Last but not least, the government needs to ensure that all regulations are abided by.

What I want to say is, you canâ€™t solve the interest rate problem by attacking the rates and dragging them down. We have to start at the root of the problem and take a host of holistic measures. Only then will rates go down.